Hybrid Financing
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 seminar class Active In SP Posts: 5,361 Joined: Feb 2011 21-02-2011, 09:36 AM   hybrid financing.ppt (Size: 393.5 KB / Downloads: 65) Hybrid Financing Preferred Stock, Leasing, Warrants, and Convertibles  Preferred stock  Leasing  Warrants  Convertibles Leasing  Often referred to as “off balance sheet” financing if a lease is not “capitalized.”  Leasing is a substitute for debt financing and, thus, uses up a firm’s debt capacity.  Capital leases are different from operating leases:  Capital leases do not provide for maintenance service.  Capital leases are not cancelable.  Capital leases are fully amortized. Analysis: Lease vs. Borrow-and-buy Data:  New computer costs \$1,200,000.  3-year MACRS class life; 4-year economic life.  Tax rate = 40%.  kd = 10%.  Maintenance of \$25,000/year, payable at beginning of each year.  Residual value in Year 4 of \$125,000.  4-year lease includes maintenance.  Lease payment is \$340,000/year, payable at beginning of each year. Depreciation schedule In a lease analysis, at what discount rate should cash flows be discounted?  Since cash flows in a lease analysis are evaluated on an after-tax basis, we should use the after-tax cost of borrowing.  Previously, we were told the cost of debt, kd, was 10%. Therefore, we should discount cash flows at 6%. A-T kd = 10%(1 – T) = 10%(1 – 0.4) = 6%. Cost of Owning Analysis Notes on Cost of Owning Analysis 1. Depreciation is a tax deductible expense, so it produces a tax savings of T(Depreciation). Year 1 = 0.4(\$396) = \$158.4. 2. Each maintenance payment of \$25 is deductible so the after-tax cost of the lease is (1 – T)(\$25) = \$15. 3. The ending book value is \$0 so the full \$125 salvage (residual) value is taxed, (1 - T)(\$125) = \$75.0. Cost of Leasing Analysis  Each lease payment of \$340 is deductible, so the after-tax cost of the lease is (1-T)(\$340) = -\$204.  PV cost of leasing (@6%) = -\$749.294. Net advantage of leasing  NAL = PV cost of owning – PV cost of leasing  NAL = \$766.948 - \$749.294 = \$17.654  Since the cost of owning outweighs the cost of leasing, the firm should lease.